Some Important Facts Related to ULIPS AND ITS Taxation By FCS Deepak Pratap Singh



 

Unit Linked Insurance Plans (ULIPs) are investment vehicles wrapped with insurance coverage.  

WIKIPEDIA;  A Unit Linked Insurance Plan (ULIP) is a product offered by insurance companies that, unlike a pure insurance policy, gives investors both insurance and investment under a single integrated plan. A Unit-Linked Insurance Plan is essentially a combination of insurance and an investment vehicle. A portion of the premium paid by the policyholder is utilized to provide insurance coverage to the policyholder and the remaining portion is invested in equity and debt instruments. The aggregate premiums collected by the insurance company providing such plans is pooled and invested in varying proportions of debt and equity securities in a similar manner to mutual funds.

Each policyholder has the option to select a personalized investment mix based on his/her investment needs and risk appetite. Like mutual funds, each policyholder's Unit-Linked Insurance Plan holds a certain number of fund units, each of which has a net asset value (NAV) that is declared on a daily basis. The NAV is the value upon which net rates of return on ULIPs are determined. The NAV varies from one ULIP to another based on market conditions and fund performance.

The attraction for ULIPs from investors’ perspective, or for comparison of product features, revolves around the investment aspects – track record of underlying fund, expenses charged, portfolio composition, etc.

The two main pillars of wealth management is  having an 

  • Insurance (medical and term both) whereas 
  • Investing in equities. 

To get a mix of both of these characteristics of financial planning,  ULIP is one of the suitable options. In ULIP investment, a small portion of money is invested towards securing your life and rest is invested in equities. Lets learn more about ULIPs in detail.

TYPES OF ULIPS

1. Equity Funds: Where the premium paid is invested in the equity market and thereby is subject to higher risk. 

2. Balanced funds: Where the premium paid is balanced between the debt and the equity market to minimise the risk for investors. 

3. Debt Funds: Where the premium is invested in debt instruments which carry a lower risk but in turn also offer a lower return.

Please Note That: Union Budget 2021;

i) Amended provisions of Income Tax Act,1961 to bring the maturity proceeds of ULIPs with an Annual Premium of more than Rs. 2,50,000/- ,to be taxable on par with Equity Oriented /Linked Mutual Funds Schemes. These provisions will be applicable on any new policy in which investors are investing after February 1, 2021.

ii) The maturity proceeds from ULIPs policies on which premium has been paid Rs. 2,50,000/- or more before February 1, 2021 will be exempted from tax.


LET’S  EXAMINE THE TAXATION RULES OF ULIPS.

DEDUCTIONS UNDER SECTION 80C

Tax benefits under section 80C of up to Rs 1.5 lakh per financial year continues to be available for life insurance policies. This is on life of self, spouse or children.

Note that deduction under section 80C, for tax benefit, is restricted to 10(%) percent of the sum assured. If a person pays a very high amount of premium for an insurance cover, the deduction shall not be allowed for the entire premium.

Deduction under section 80C is allowed only if you contribute to the ULIP for the first five years of the plan.

The more important provision in the context of taxation of ULIPs is section 10(10D). This section provides that maturity proceeds, including bonus, are exempt from tax. The requirement is that the annual premium payable for the policy should not exceed 10 percent of the sum assured. If at any time, the premium for the year exceeds 10 percent of the sum assured, the proceeds become taxable. There is no change here as well in the Finance Act 2021-22.

NEW RULES- The Finance Act 2021-22 ; states that no exemption shall be available for ULIPs issued after February 1, 2021 (the day of the presentation of the Union Budget), if the amount of premium for any of the years during the term of the policy exceeds Rs 2,50,000/-.

PRIOR PERIOD STATUS

Hence, if an investor holds a ULIP policy that was bought prior to February 1, 2021, irrespective of the amount of premium paid, the maturity proceeds are tax-free.

AFTER AMENDMENT;

Where the investor holds multiple policies, issued after Feb 1, 2021, proceeds will be tax-free as long as each policy has premium less than Rs 2,50,000/- and the aggregate of all the policies of the investor (as per the PAN) is less than  Rs 2,50,000/- .

If the investor has multiple policies with some policies of less than Rs2,50,000/-  premium and some with higher premium, those policies with less than Rs. 2,50,000/-  premium, individually and as an aggregate, will be exempt from tax.

LET US TAKE AN EXAMPLE. Mr A has four ULIPs, with premium amount of Rs 1,00,000, Rs 75,000, Rs 50,000 and Rs 40,000, respectively per year.

The first three policies are all of less than Rs. 2,50,000/- (Rs. 1.00+0.75+0.50)lakh and the aggregate is Rs 2.25 lakh per year, and will be exempt from tax. The last one will not be exempt because if we add that, aggregate premium would be more than Rs. 2,50,000/-.

From another perspective, it is possible to leave out one of the first three and claim the last one, of Rs 40,000 premium for tax exemption. However, that would not be optimum as the aggregate amount claimed for exemption would be less than Rs 2.25 lakh for Mr A.

TAXATION OR TAX RATE.

Policy proceeds will be taxed as capital gains. The time period, for computation of long-term or short-term nature of capital gains will be counted from the date of payment of premium (separately for each payment) till the date of receipt of maturity proceeds. The bifurcation between long and short term is a time period of one year. Long-term capital gains are taxable at 10 percent plus surcharge and cess as applicable.

NOTE: TAX RATES ARE AS FOLLOWS;

1. Short Term Capital Gain( Section 111A) – holding assets or ULIPs one year or less -If STT has been paid - @15% + Surcharge +HESC

2. Long Term Capital Gain( Section 112A)- @10% + Surcharge +  HESC

NOTE: that in case  payment of premium in instalments or through SIPs ,the nature of Capital Gains will be decided separately for payment of each SIPs or instalments. Suppose Mr. A is investing in ULIP through yearly SIPs and he is paying SIPs since last two  previous years i.e. on 01.04.2019 and 01.04.2020 and so on in this case his capital gains on  maturity proceeds will be calculated from respective date of payment of SIPs.

If the ULIP fund has more than 65 percent of the portfolio in equity, it will be classified as equity for capital gains taxation.

In equity investments, long-term capital gains are tax-exempt upto Rs 1 lakh per financial year, but that is along with investments in equity stocks and equity-oriented mutual funds. Hence if the ULIP investor has investments in equity stocks and/or equity mutual funds and has booked profits in that financial year, only the balance will be available for ULIPs.

If the taxation on the final proceeds is due to breach of Section 10(10D), i.e., premium exceeding 10 percent, it is taxable at your marginal slab rate, usually 30 percent plus surcharge and cess. If it is due to breach of the threshold of Rs 2.5 lakh, it is taxable as capital gains.

CONCLUSION:

It is advisable to  check applicable provisions of Income Tax Act before taking decision to invest in ULIPs. You have to check;

i) The premium payment during a year will not exceed 10% of Sum Assured under ULIPs;

ii) The total premium payment during year in case of multiple ULIPs should not exceed Rs. 2,50,000/- in a year;

iii) The nature of capital gains will be decided on the basis of payment of each ULIPs premium instalments or SIPs;

iv) The Long Term Capital Gain will be taxable @10% on maturity proceeds in excess of Rs. 1.00 lakhs during year;

v) Please note that above reduce rate of taxation @10% will available only for Long Term Capital Gains and not for Short term Capital Gains;

vi) Short Term Capital Gains will be taxable on the basis of slab rate applicable on individual & HUFs;

vii) If payment of premium during year in respect of a ULIPs exceeds 10% of Sum Assured during year or if it breached threshold limit of Rs.2,50,000/- during the year then it will be taxable based on maximum marginal rate;

viii) The maturity amount is tax free in the hand of investors but subject to above conditions;

ix) Please note that you have to complete at least five years to avoid surrender charges and claim maturity value as tax free, otherwise the maturity proceeds or surrender value will be added in your income in the and same will be taxable on the basis of period of holding of ULIPs.

x) It means minimum lock-in period for ULIPs is 5(five) years;

xi) Please note that non-payment of premium till five years ,the ULIPs policy will automatically converted into a Reduced Paid Up Policy;

xii) TDS will also be deducted on bonus payments. If the amount received is less than Rs 1,00,000, no TDS shall be deducted but the amount received shall be fully taxable for you. You can claim credit for the TDS deducted in your Income Tax Return;

xiii) Surrendering during the lock-in period - ULIPs have a lock-in period of 5 years but investors can surrender the fund before completion of the lock-in tenure. The risk-cover will cease once you submit the request for surrender, however, the surrender value incurred is paid only at the end of the 5-year term.

 

Lex comply

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